ESSAYS ON CROSS-BORDER MERGERS AND ACQUISITIONS

Transcription

1 ESSAYS ON CROSS-BORDER MERGERS AND ACQUISITIONS Peng Huang A thesis submitted to the University of New South Wales in fulfilment of requirements for the degree of Doctor of Philosophy (PhD) School of Banking and Finance Australian School of Business July 2014

2 To my parents, my wife Susanna and my daughter Grace

3 PLEASE TYPE THE UNIVERSITY OF NEW SOUTH WALES Thesis/Dissertation Sheet Surname or Family name: Huang First name: Peng Other name/s: Abbreviation for degree as given in the University calendar: PhD School: School of Banking and Finance Faculty: Australian School of Business Title: Essays on cross-border mergers and acquisitions Abstract 350 words maximum: (PLEASE TYPE) Cross-border M&As are important corporate decisions. They are different from domestic M&As in that acquirers have potentially more investment opportunities, but also greater challenges. This thesis provides new evidence on why acquirers undertake cross-border deals, and how they manage the additional challenges that arise in cross-border deals. The thesis first examines the role of country-level innovation in driving the decision to make cross-border instead of domestic M&As. Country-level and country-pair-level evidence shows that acquirers in low innovation countries are more likely to do a cross-border deal, and are more likely to acquire a target in a relatively higher innovation country. Deal-level evidence suggests that higher innovation acquirers in low innovation countries are more likely to undertake cross-border deals, and earn higher returns from cross-border deals than from domestic deals. Further, acquirers in low-innovation countries typically target relatively higher innovation targets in cross-border deals than in domestic, holding other factors constant. The thesis then investigates the choice of payment method in cross-border M&As as a mechanism to manage the additional risks when compared to domestic deals. It shows that an all cash option is the preferred payment method for all M&A deals, but that its use in cross-border deals is significantly more likely than in domestic. Further, it finds an increase in the use of stock in cross-border deals involving higher relative risk target countries. For more recent periods, there is a close convergence of payment method used in cross-border and domestic deals. These findings are consistent with risk reduction theories related to information asymmetry and overpayment. Lastly, the thesis examines the cross-country and cross-border determinants of the choice between partial and majority acquisitions, and provides new country-level evidence showing that acquirers balance the choice of acquisition form based on the legal, economic and financial regimes. In particular, stronger shareholder protection, better disclosure quality, and more developed equity markets all encourage majority as opposed to partial acquisitions. Further, there are more partial acquisitions in cross-border M&As. Greater geographic distance, different language, or different legal and economic regimes between two countries all result in more partial acquisitions. Declaration relating to disposition of project thesis/dissertation I hereby grant to the University of New South Wales or its agents the right to archive and to make available my thesis or dissertation in whole or in part in the University libraries in all forms of media, now or here after known, subject to the provisions of the Copyright Act I retain all property rights, such as patent rights. I also retain the right to use in future works (such as articles or books) all or part of this thesis or dissertation. I also authorise University Microfilms to use the 350 word abstract of my thesis in Dissertation Abstracts International (this is applicable to doctoral theses only). Signature.. Witness..... Date The University recognises that there may be exceptional circumstances requiring restrictions on copying or conditions on use. Requests for restriction for a period of up to 2 years must be made in writing. Requests for a longer period of restriction may be considered in exceptional circumstances and require the approval of the Dean of Graduate Research. FOR OFFICE USE ONLY Date of completion of requirements for Award: THIS SHEET IS TO BE GLUED TO THE INSIDE FRONT COVER OF THE THESIS

4 ORIGINALITY STATEMENT I hereby declare that this submission is my own work and to the best of my knowledge it contains no materials previously published or written by another person, or substantial proportions of material which have been accepted for the award of any other degree or diploma at UNSW or any other educational institution, except where due acknowledgement is made in the thesis. Any contribution made to the research by others, with whom I have worked at UNSW or elsewhere, is explicitly acknowledged in the thesis. I also declare that the intellectual content of this thesis is the product of my own work, except to the extent that assistance from others in the project's design and conception or in style, presentation and linguistic expression is acknowledged. Signed... Date...

5 COPYRIGHT STATEMENT I hereby grant the University of New South Wales or its agents the right to archive and to make available my thesis or dissertation in whole or part in the University libraries in all forms of media, now or here after known, subject to the provisions of the Copyright Act I retain all proprietary rights, such as patent rights. I also retain the right to use in future works (such as articles or books) all or part of this thesis or dissertation. I also authorise University Microfilms to use the 350 word abstract of my thesis in Dissertation Abstract International (this is applicable to doctoral theses only). I have either used no substantial portions of copyright material in my thesis or I have obtained permission to use copyright material; where permission has not been granted I have applied/will apply for a partial restriction of the digital copy of my thesis or dissertation.' Signed... Date... AUTHENTICITY STATEMENT I certify that the Library deposit digital copy is a direct equivalent of the final officially approved version of my thesis. No emendation of content has occurred and if there are any minor variations in formatting, they are the result of the conversion to digital format. Signed... Date...

6 ACKNOWLEDGEMENTS First and foremost I want to express my heartfelt thanks and respects to my supervisors, Dr Ronan Powell and Dr Mark Humphery-Jenner. I am lucky to have had the opportunity to work with them. I would not have been able to come through all the difficulties to complete this thesis without their continuing guidance, assistance, support and contributions. Furthermore, their professional dedication, and the rigorous attitude and enthusiasm towards academic research have shaped me as an independent researcher, and will significantly and positively influence my career life in the long-term. I am deeply indebted to Ronan, firstly for his accepting me and taking the supervisory responsibility when I was confronted with setbacks. Not only that, Ronan has devoted much of his time and energy to guiding me through all the steps to complete this thesis. He always gives me intellectual freedom in my research, engages me in forming new ideas, demands high quality work, meets me frequently to discuss my progress and to provide suggestions, and responds to my questions and requests timely, earnestly and constructively (e.g. I have searched my box by sender name and found that there are several hundred s from Ronan within the past year!). He is always encouraging and constructive, which is particularly important for me to regain faith and confidence. Ronan has spent a lot of time and effort in helping me improve and polish the thesis. Moreover, the attitude and spirit with which Ronan treats the research and guides the students are what I would like to follow. I am also grateful to Mark, for his taking the important co-supervisory position, especially when Ronan was on leave. Mark is the smartest, most knowledgeable and the best organized person I have ever met. His inspiring and constructive guidance and assistance have made me able to complete the thesis on time. It is an exciting and valuable i

7 experience to work with him, whose optimism, innovation and cooperation have infected me and brought me greater incentives, efficiency and sense of achievement, as well as a better understanding on how to improve my research ability. Mark has also spent a lot of time and effort in helping me improve and polish the thesis. He has also made me familiar with academic life, which is helpful for me to make forward-looking research plans. I would not have had the chance to start writing this thesis without the work and assistance from many individuals and groups. I thank Dr Chris Carter, Dr Peter Pham, Dr Bill Schworm, Dr Jo-An Suchard and the School of Banking and Finance Research Committee, for providing coordination and support for my research studies. I would like to thank the valuable comments and suggestions on Chapter two from Dr René Adam, Dr Lixiong Guo, Dr Ronald Masulis, and Dr Peter Swan. I also thank Dr Rachida Ouysse, Dr Valentyn Panchenko, Dr Nigel Stapledon, Dr Minxian Yang, Dr Jason Zein, the fellow students, and several other academic staff, who have influenced my research and helped me in some way during the past four years. The work from administration staff in the school is also important and is highly appreciated. Last, but not the least, I would never have arrived here without the continuing love, support and tolerance from my family. I thank my parents for their unconditional love, and moral and financial support throughout my 23-year student life. I am also indebted to my parents and parents-in-law, for their unconditional support in helping my wife and I take care of my daughter. I am lucky to have my wife Susanna Yue Lu, and my daughter Grace Huang in my life, which gives me the most courage and motivation to complete the thesis. Special thanks go to my wife, who has been taking care of the family in hard times with consistent love and patience so that I was able to focus on the thesis. ii

8 ABSTRACT Cross-border M&As are important corporate decisions. They are different from domestic M&As in that acquirers have potentially more investment opportunities, but also greater challenges. This thesis provides new evidence on why acquirers undertake cross-border deals, and how they manage the additional challenges that arise in cross-border deals. The thesis first examines the role of country-level innovation in driving the decision to make cross-border instead of domestic M&As. Country-level and country-pairlevel evidence shows that acquirers in low-innovation countries are more likely to do a cross-border deal, and are more likely to acquire a target in a relatively higher-innovation country. Deal-level evidence suggests that higher-innovation acquirers in low-innovation countries are more likely to undertake cross-border deals, and earn higher returns from cross-border deals than from domestic deals. Further, acquirers in low-innovation countries typically target relatively higher-innovation targets in cross-border deals than in domestic, holding other factors constant. The thesis then investigates the choice of payment method in cross-border M&As as a mechanism to manage the additional risks when compared to domestic deals. It shows that an all cash option is the preferred payment method for all M&A deals, but that its use in cross-border deals is significantly more likely than in domestic. Further, it finds an increase in the use of stock in cross-border deals involving higher relative risk target countries. For more recent periods, the use of stock (cash) has increased (decreased) significantly in cross-border deals, resulting in the close convergence with payment method used in domestic deals. Further analysis shows that the relative risk of cross-border deals has increased for bidders in more recent periods, suggesting that bidders during this period targeted higher-risk countries. The observed increased use of stock in more recent iii

9 cross-border deals is consistent with risk reduction theories related to information asymmetry and overpayment. Lastly, the thesis examines the cross-country and cross-border determinants of the choice between partial and majority (i.e., controlling) acquisitions, and provides new country-level evidence showing that acquirers balance the choice between partial and majority acquisitions based on the legal, economic and financial regimes. In particular, stronger shareholder protection, better disclosure quality, and more developed equity markets all encourage majority as opposed to partial acquisitions. Further, there are significantly more partial acquisitions in cross-border M&As, which is strongly related to the costs to acquire information abroad. In particular, greater geographic distance, different language, or different legal and economic regimes all result in more partial acquisitions between two countries. iv

10 TABLE OF CONTENTS ACKNOWLEDGEMENTS... i ABSTRACT... iii TABLE OF CONTENTS... v LIST OF TABLES... vii LIST OF FIGURES... viii CHAPTER 1 INTRODUCTION MOTIVATION OF THE THESIS STRUCTURE AND MAIN FINDINGS OF THE THESIS... 2 CHAPTER 2 INNOVATION AND CROSS-BORDER MERGERS AND ACQUISITIONS INTRODUCTION HYPOTHESES DATA Sample Construction Time Series of Cross-border M&As Country-pair Comparisons MULTIVARIATE REGRESSIONS Acquirer-country Analysis Country-pair Analysis Country-Pair Panel Data Analysis Deal-level Analysis Robustness Tests CONCLUSION CHAPTER APPENDIX VARIABLE DEFINITIONS CHAPTER 3 THE CHOICE OF PAYMENT METHOD IN CROSS-BORDER AND DOMESTIC MERGERS AND ACQUISITIONS INTRODUCTION HYPOTHESES DEVELOPMENT VARIABLE DEFINITIONS AND ECONOMETRIC MODELS Country-level Variables Deal and other Characteristics Econometric Models v

11 3.4 DATA AND SUMMARY STATISTICS Summary Statistics REGRESSION RESULTS The Time Series of the Method-of-Payment Choice Robustness Tests CONCLUSIONS CHAPTER APPENDIX VARIABLE DEFINITIONS CHAPTER 4 THE CHOICE OF ACQUISITION FORM AROUND THE WORLD INTRODUCTION LITERATURE REVIEW AND HYPOTHESES Sovereign Governance Equity Market Development Cross-border Barriers Stepping-stone Acquisitions SAMPLE SELECTION DESCRIPTIVE STATISTICS MULTIVARIATE REGRESSIONS Minority Acquisitions, Governance, and Economic Development Minority Acquisitions in Cross-border M&As Minority Acquisitions as Stepping-stone Acquisitions Robustness Tests CONCLUSION CHAPTER APPENDIX VARIABLE DEFINITIONS CHAPTER 5 CONCLUSION AND SUGGESTIONS FOR FUTURE RESEARCH CONCLUSION OF THE THESIS AVENUES FOR FUTURE RESEARCH REFERENCES vi

12 LIST OF TABLES Table 2.1 Cross-border M&As, country-level innovation and firm-level innovation Table 2.2 Summary Statistics Table 2.3 Determinants of Acquirer-country Cross-border Ratio Table 2.4 Determinants of Country-pair Cross-border Ratio Table 2.5 Panel Analysis of Annual Country-pair Cross-border Ratio Table 2.6 The likelihood of cross-border M&As (continuous innovation measures) Table 2.7 The likelihood of cross-border M&As (dummy innovation measures) Table 2.8 Cross-border Acquisition and Relative Target to Acquirer Innovation Table 2.9 Cross-border Acquisitions and Target Patenting Activity Table 2.10 Wealth Effects of Cross-border Acquisitions Table 2.11 Logit Models Predicting Likelihood of a Value-creating Deal Table 2.12 Propensity-score Matching Models Table 2.13 Weighting Models Table 3.1 Sample Composition and Differences in Method-of-payment Table 3.2 Payment Method Choice around the World Table 3.3 Time Series of Payment Method Choice Table 3.4 Proportion of All Cash Deals around the World Table 3.5 Summary Statistics Table 3.6 Method of Payment Probit Regressions Table 3.7 Method of Payment Regressions and Convergence Table 3.8 Method of Payment Probit Regressions: Additional Robustness Tests Table 4.1 Partial Acquisitions around the World Table 4.2 Summary Statistics Table 4.3 Sovereign Governance and Partial Acquisitions Table 4.4 Partial Acquisitions in Cross-border Deals Table 4.5 Determinants of Cross-border Partial Acquisitions Table 4.6 Stepping-stone Acquisitions vii

13 LIST OF FIGURES Figure 1.1 Time-series of Cross-border M&As... 1 Figure 2.1 Cross-border M&As over the Period Figure 2.2 Cross-border Ratio by Country-pair Groups Figure 3.1 Time Series of the Payment Method Figure 3.2 Time Series of Cross-border M&A Relative Risk Figure 4.1 Aggregate Valuation of Partial Acquisitions Figure 4.2 Frequency of Partial Acquisitions viii

14 CHAPTER 1 INTRODUCTION 1.1 MOTIVATION OF THE THESIS This thesis is about mergers and acquisitions (M&As), with a particular focus on crossborder M&As. Cross-border M&As have played an increasingly important role in the world economy during the past decades. Cross-border M&As represent around 24% of all M&A activity. Moreover, the world-wide aggregate dollar value of cross-border M&As as a percentage of total GDP increased to a high of 5.03% in 2007 from only 0.94% in 1990 (Figure 1.1). Aggregate value of cross-border M&As/GDP 6% 5% 4% 3% 2% 1% 0% Ratio of cross-border M&As/all M&As 27% 26% 25% 24% 23% 22% 21% 20% 19% Figure 1.1 Time-series of Cross-border M&As The ratio of aggregate valuation of cross-border M&As to world GDP and the ratio of cross-border M&As to all M&As. (Source: SDC Mergers and Acquisitions Database, all deals from 1990 to 2010) 1

15 Cross-border M&As are different from domestic M&As in that acquirers have potentially more investment opportunities, but face greater challenges. On the one hand, cross-border M&As can provide acquirers with new distribution networks and synergy opportunities. It is also a potential channel through which to acquire innovation and growth opportunities. On the other hand, information asymmetry, different legal and economic regimes, as well as political and financial risks are prominent barriers to making (successful) cross-border M&As (Moeller and Schlingemann, 2005; Jandik and Kali, 2009; Reus and Lamont, 2009; Raggozino and Reuer, 2010). This thesis investigates these issues and provides new evidence on what motivates cross-border M&As. In particular, the thesis examines different aspects of how acquirers deal with the trade-off between the opportunities and challenges in cross-border M&As. 1.2 STRUCTURE AND MAIN FINDINGS OF THE THESIS This thesis first examines why firms make cross-border instead of domestic M&As. Cross-border M&As can provide greater opportunities to acquirers. The prior literature has examined some of the firm-level and country-specific drivers of cross-border M&A activity (Rossi and Volpin, 2004; Ferreira, Massa, and Matos, 2010; Erel, Liao, and Weisbach, 2012b). Chapter two enriches this strand of literature by examining the role of innovation in driving the decision to make cross-border instead of domestic M&As. The central premise is that prospective acquirers in low-innovation countries (as proxied by a dearth of patenting activity, R&D, and researchers) are faced with relatively few targets who are both innovative and are synergistic. Subsequently, such firms will seek to expand the set of potential targets by making cross-border acquisitions. Based on the literature, chapter two forms several hypotheses and utilizes both country-level and deal-level analyses to answer the following questions: 1) Does country-level 2

16 innovation influence the decision to make cross-border M&As? 2) How does firm-level innovation interact with country-level innovation? 3) Do innovation-driven cross-border M&As create value for acquirers? 4) Why does country-level innovation matter? The empirical results provide clear answers to these questions and demonstrate strong support for the hypotheses. The results show that there are more cross-border M&As from low-innovation countries, especially for the high-innovation firms. The results also show that acquirers from low-innovation countries are more likely to target more innovative firms in cross-border M&As. Further, such innovation-driven cross-border M&As can provide high-innovation acquirers greater growth opportunities. In all, this chapter uncovers a new country-level factor that motivates cross-border M&As. Notwithstanding the potential opportunities involved in undertaking a cross-border deal, cross-border deals also involve greater risks and challenges. The extra risks and challenges make cross-border deals more difficult to execute and more costly than domestic deals, which dampens acquirers willingness to pursue more (possibly better) opportunities around the world. The next two chapters of the thesis switch the focus from why firms buy foreign firms to how they overcome the barriers when they invest abroad. In particular, chapter three and four examine the ways through which acquirers deal with the greater challenges in cross-border M&As, and the country-factors affecting these decisions. Chapter three investigates the choice of payment method in cross-border M&As, compared with domestic M&As. The chapter first provides comprehensive evidence on the differences in payment method choice between cross-border and domestic M&As. Both univariate and multivariate analyses show that there are more cash deals in crossborder M&As around the world. The chapter then investigates the country-level determinants of payment method choice in cross-border M&As by measuring the relative risk 3

17 of the bidder-target countries using several risk indices that capture several factors, including governance quality, political stability, accountability and transparency. The results from multivariate regressions show that stock payment is more likely to be used when bidders target higher relative risk countries. Furthermore, this chapter examines the evolution of payment method choice over time and provides potential answers for the observed convergence in payment method choice in cross-border and domestic deals. Specifically, both univariate and multivariate evidence shows that while there is a higher proportion of cross-border M&As than domestic M&As are financed with cash (rather than stock), the difference between cross-border and domestic deals shrinks over time. This convergence can be partially explained by the fact that there are an increasing number of cross-border deals involving low-risk acquirer countries and high-risk target countries. These findings on the choice of payment methods are consistent with the risk reduction theories related to information asymmetry and overpayment. Chapter four of the thesis investigates another channel through which acquirers can balance the benefits and costs of doing cross-border M&As, namely, the choice of acquisition form. As shown in prior studies, partial acquisition, as compared with a majority (controlling) acquisition, can be more desirable when full integration is less efficient. The chapter first reports evidence on the variation of the likelihood of partial acquisitions across countries, followed by an examination of the cross-country and cross-border determinants of partial and majority acquisitions. The empirical results show that more partial acquisitions occur in countries with weaker sovereign governance and less developed equity markets. Lastly, the chapter compares the use of partial acquisitions in cross-border and domestic M&As, and provides evidence on the factors determining the choice of acquisition form in cross-border deals. In particular, the results indicate that partial acquisi- 4

18 tions are positively related to the geographic distance between acquirer and target countries, whether acquirer and target countries have the same language, and whether they have close legal, political and economic relationship in their history. The chapter highlights that acquirers making partial acquisitions in cross-border M&As are motivated by the desire to reduce the risk and uncertainty, and to overcome the greater frictions and barriers that arise in cross-border deals. The last chapter of the thesis concludes and provides insights for further research on (cross-border) M&As. 5

19 CHAPTER 2 INNOVATION AND CROSS-BORDER MERGERS AND ACQUISITIONS Chapter summary This chapter examines the relationship between innovation and cross-border M&As. I present country-level and country-pair-level evidence that acquirers in low innovation countries are more likely to do a cross-border deal, and are also more likely to acquire a target in a relatively higher innovation country. Further, deal-level evidence suggests that higher innovation acquirers in low innovation countries are more likely to undertake cross-border deals, target relatively higher innovation targets when doing so, and earn higher returns from these deals when compared to domestic deals. The results indicate that the acquisition of innovation is an important and value-enhancing driver of crossborder takeovers. 6

20 2.1 INTRODUCTION This chapter examines the role of innovation as a motivation for cross-border M&As. Cross-border M&As have increased in importance in recent times. For example, in 2012, cross-border M&As accounted for 36% of all M&A activity (Thomson Reuters, 2012), compared to about 25% for the 1990s period (Erel et al., 2012). However, cross-border M&As are costly, time-consuming, and can involve difficulties of integrating divisions across borders. This begs the question of why companies might engage in cross-border M&A activities. The prior literature has provided evidence of some firm-level and country-specific drivers of cross-border M&A activity. These include higher relative acquirer stock value, higher relative country currency, geography (relative distance), gaining access to better capital markets, and to improve target firm governance (Rossi and Volpin, 2004; Ferreira et al., 2010; Erel et al., 2012). However, an additional possibility is innovation. R&D has become increasingly internationalized within multi-segment firms (UNCTAD, 2005; OECD, 2007; D Agostino et al., 2013). Further, the acquisition of R&D intensive targets can be a motivation for domestic acquisitions (Bena and Li, Forthcoming). Subsequently, acquirers in low innovation countries, who face a dearth of innovative targets from which to choose (only a sub-set of which might be synergistic), might seek to avail themselves of the larger selection of innovative targets overseas. In this chapter, I examine the acquisition of innovation as a motive for cross-border M&As. Cross-border acquisitions can be one way to acquire innovation, and may offer several advantages over creating internal innovation. Firms in relatively low innovation countries will likely face greater barriers to obtaining the human capital necessary to generate innovation, rendering it comparatively more difficult to generate internal innovation with domestic resources in a low innovation country. Additionally, firms located in lower 7

21 innovation countries also face poor intellectual property (IP) protection rights, and barriers to enforcing those rights (following He and Su, 2013), which can deter the internal development of innovation due to higher risk of expropriation (see e.g. Xiao, 2013). Acquiring a high innovation firm from a country with greater IP protection rights reduces the risk of expropriation. Finally, low innovation countries are likely to have fewer targets that are both synergistic and innovative, so a firm (especially a high-innovation firm) in a low innovation country will benefit more by engaging in cross-border takeovers to acquire innovation. While it is true that innovation can sometimes be difficult to manage at a distance (Belderbos et al., 2013; Lutz et al., 2013), and that global diversification can reduce firmvalue (Denis et al., 2002), firms have become increasingly capable of efficiently managing innovation at a distance or across countries (Castellani et al., Forthcoming). Thus, at a macro-economic level, this would involve purchasing a target (especially a high-innovation one) in a relatively higher innovation country. I ask the question of whether country-level innovation motivates cross-border deals, especially for high innovation acquirers, and whether these deals create value for the acquirer. I hypothesize that acquirers in relatively low innovation countries are more likely to undertake acquisitions of targets in relatively high innovation countries (after controlling for other factors that might influence takeover activity). I also expect that such acquisitions will create value for the acquirer, in part by providing access to valuable growth-opportunities. Prior literature shows that innovation can be a motivation for domestic acquisitions (Bena and Li, Forthcoming); however, cross-border deals warrant a separate analysis. A study of cross-border deals allow me to examine whether, and why, acquirers in low innovation (i.e. less developed) countries might acquire targets in high innovation (i.e. more 8

22 developed) countries. This contrasts with prior cross-border M&A literature that has focused on the motivation for acquirers in developed countries to acquire targets in less developed countries (Francis et al., Forthcoming; Bris et al., 2008; Martynova and Renneboog, 2008; Kim and Lu, 2013). Thus, the cross-border context allows me to contribute to the literature on the motivation for, and value-drivers of, cross-border deals. This cross-border context is also important given that cross-border M&As accounted for 36% of all M&A activity in 2012 (Thomson Reuters, 2012). I test these hypotheses by using a sample of 85,549 acquisitions from 57 countries from I perform the analysis at the acquirer-country level, acquirer-target country-pair level, and at the deal level. I use several patent-based and non-patent-based proxies for the country s level of innovation, including measures for the country s R&D intensity and its number of researchers. One issue with the patent-based measures is that the level of IP property protection in a country influences the level of patenting, which can result in some low-protection countries appearing to be even lower innovation on patent-based metrics. However, this is not a major concern for my study, as a lack of IP protection can deter innovative activities (Belderbos et al., 2013), suggesting that it is plausible, and consistent with my argument, that firms from poor-ip-protection countries might seek to acquire innovation overseas. Further, the use of non-patent-based measures of innovation helps to mitigate concerns that the level of patenting might merely reflect the level of property rights protection. I first test how the level of innovation in the acquirer s country influences the number of cross-border acquisitions made from that country. I then examine how the difference in innovation between the acquirer s country and the target s country influences the number of cross-border M&A activity between those countries. Finally, I analyze the impact of country-level innovation at the deal level. 9

23 Three pieces of evidence support my arguments. First, the country-level evidence suggests that acquirers from low innovation countries are more likely to do cross-border deals. Second, cross-border M&As are more likely to take place between countries with a larger innovation differential. Specifically, acquirers in less innovative countries tend to buy more firms, on average, from higher innovation countries. Third, I find deal-level evidence that acquirers in relatively low innovation countries are more likely to make cross-border acquisitions. This is especially the case if the acquirer is itself a high-innovation firm (in a relatively low innovation country). Firms in low-innovation countries also do more cross-border deals to acquire targets with relatively higher levels of R&D and patent-intensity. Further, high innovation acquirers in low innovation countries experience higher returns from cross-border deals than they do from domestic ones, indicating that investors expect them to deliver greater future performance benefits. These results suggest that firms in low innovation countries can use cross-border deals as a way to access value-creating innovation and growth-prospects. The results make a significant contribution to the literature. First, I investigate, and highlight, a neglected motivation for cross-border takeovers the acquisition of innovation. Prior literature has examined the role of innovation in domestic acquisitions (Bena and Li, Forthcoming). However, a separate analysis of cross-border deals is important given both the growing importance of cross-border deals, the unique challenges that such deals present, and the potential issues of integrating innovation across-borders. Furthermore, I highlight the role of country-level innovation-characteristics in driving cross-border deals and analyse an additional factor, being innovation, which can moderate the performance of such deals. Second, whereas prior literature has focused on the flow of takeover activity from acquirers in developed countries to targets in developing countries, I highlight a situation 10

24 in which the opposite flow can occur. Some prior studies do document the drivers of cross-border M&A. Sarala and Vaara (2010) analyse a study of Finnish corporations, and find that cultural differences can facilitate knowledge transfers. Given that the focus is on acquirers in Finland (a developed, high-innovation country), it remains an open question as to whether the acquisition of innovation can explain the cross-border activity from acquirers in low-innovation countries, and whether such acquisitions create value. Erel et al. (2012) analyse several key determinants of cross-border deals, which I control for in my regressions. Ferreira et al (2010) examine the role of institutional investors in crossborder M&A. However, neither Erel et al. (2012) nor Ferreira et al. (2010) analyse the role of innovation in driving cross-border M&A activity (in general), and whether this can explain cross-border deals from low-innovation countries (in particular). Third, I present evidence of an additional driver of takeover returns in cross-border acquisitions. The results imply that the acquisition of innovation (including the innovativeness of the acquirer and of its country) influences takeover returns. Fourth, I help to highlight that not all cross-border acquisitions destroy value (as the prior literature shows), on average, with the value-implications depending on the motivation for the acquisition. That is, there is heterogeneity in the performance of cross-border deals (see e.g. Seth et al., 2002; Moeller and Schlingemann, 2005), which, in this study, is shown to vary with innovativeness. Overall, this chapter presents a new motive for cross-border deals, and demonstrates that it can influence deal-performance. The structure of this chapter is as follows. Section 2 develops the hypotheses and discusses the relevant prior literature. Section 3 describes the sample construction and provides summary statistics. Section 4 contains the multivariate regression analyses and robustness checks, and Section 5 concludes. 11

25 2.2 HYPOTHESES The knowledge based view of the firm states that heterogeneous knowledge bases and capabilities among firms are the main determinants of performance differences (Dierickx and Cool, 1989, p 954). Firms can generate knowledge internally (i.e. through R&D) and externally (i.e. through acquisitions). Thus, innovation can be one motive for acquisitions (Bena and Li, Forthcoming; Haleblian et al., 2009; Sevilir and Tian, 2012). Such innovation-directed acquisitions often involve the acquisition of an R&D-intensive target by a larger incumbent (Bena and Li, Forthcoming). For example, Erel et al. (Forthcoming) suggest that cash-rich acquirers can acquire innovation-rich, but cash-poor targets, potentially to facilitate innovation. The literature has presented mixed results on the benefits of acquiring innovation-through-acquisitions, often showing that its efficacy depends on the characteristics of the acquirer (Ahuja and Katila, 2001; Kapoor and Lim, 2007; Desyllas and Hughes, 2010; Makri et al., 2010). One such characteristic is likely to be the level of innovation in the acquirer s country. In a low-innovation country, there is likely to be a comparative dearth of innovative targets to acquire, and a lack of latent macroeconomic growth options. Subsequently, domestic acquisitions are likely to be a less successful method of acquiring innovation in a relatively low innovation country, especially for high-innovation firms. Cross-border M&As could facilitate the acquisition of innovation, especially for acquirers domiciled in a low innovation country. Macroeconomic effects can influence the decision to undertake cross-border M&As (Rossi and Volpin, 2004; Pablo, 2009; Ferreira et al., 2010; Hyun and Kim, 2010; Owen and Yawson, 2010; Erel et al., 2012). One such macroeconomic effect is a country s knowledge potential and growth potential, as represented by its level of innovation. Thus, the technology-sourcing literature suggests 12

26 that FDI 1 should flow from low innovation countries to high innovation countries as firms seek to gain access to the growth opportunities in high innovation countries (Kogut and Chang, 1991; Neven and Siotis, 1996; Anand and Kogut, 1997). Relatedly, prior literature suggests that emerging-market firms can increase their knowledge-base and organizational learning by interacting with firms in developed markets (Zhong et al., 2013). Subsequently, an acquirer in a low innovation country would be more likely to undertake a cross-border takeover, especially of a target in a higher innovation country. The benefits of engaging in such cross-border deals should be especially strong for high-innovation firms. High-innovation firms can pursue a strategy of developing innovation both internally (i.e. through R&D) and externally (i.e. through acquisitions). Both methods of innovating are complementary. When pursuing innovation-through-acquisitions, the target must be both innovative and synergistic (i.e. culturally and technologically compatible). In low-innovation countries, there is (by definition) a relative dearth of targets that are innovative, and an even smaller number targets that are both innovative and synergistic. By contrast, the pool of such targets is larger in a higher innovation country. Thus, a high innovation firm in a low innovation country would be especially likely to engage in cross-border deals as compared with a high innovation firm in a high innovation country. I capture these predictions in the following country-level, country-pairlevel, and deal-level hypotheses. Hypothesis 1 (country-level): Countries with lower levels of innovation will feature more out-bound M&A than countries with higher levels of innovation. That is, a greater 1 M&As can form part of FDI. However, there are other forms of FDI that are unrelated to corporate investment activity. For example, inter-company loans and retained earnings are both included in FDI, but they are not relevant to the current study and may add noise to the analysis. Furthermore, the measuring standards for the non-investment component of FDI am different across countries, which makes crosscountry FDI data less comparable. As a result, I follow the practice in prior studies and focus on traditional M&As. (Rossi and Volpin, 2004; Erel, Liao and Weisbach, 2012) 13

27 proportion of deals done by acquirers in low innovation countries will be out-bound cross-border deals, when compared with deals done by acquirers in high innovation countries. Hypothesis 2 (country-pair-level): A greater proportion of deals done by acquirers in low innovation countries will be cross-border deals for targets in high innovation countries (as compared to the proportion of deals done by acquirers in high innovation countries). Hypothesis 3 (deal-level): High innovation acquirers in low innovation countries are more likely to do a cross-border deal than a domestic one when compared with high innovation acquirers in high innovation countries. I expect that acquirers in low innovation countries are more likely to acquire targets with relatively higher levels of innovation. Prior literature suggests that knowledge/innovation-transfers can be a motivation for cross-border acquisitions (Sarala and Vaara, 2010; Frey and Hussinger, 2011), with cross-border buyers often targeting firms with greater growth prospects (Nagano and Yuan, 2013), or patenting (Ali-Yrkko et al., 2005). These cross-border acquirers also tend to adopt foreign technologies (Guadalupe et al., 2012), and increase R&D expenditure in the target-affiliates that they acquire. 2 Therefore, given the expectation that acquirers in low innovation countries are likely to aim to acquire innovation, I expect that acquirers in low innovation countries will seek targets with a relatively higher level of innovation. 2 Bertrand et al. (2012) find supportive evidence in acquisitions by Swedish MNEs, although evidence from Germany suggests that foreign acquirers diminish R&D (Stiebale and Feize, 2011). 14

28 Hypothesis 4 (deal-level): Firms in low innovation countries will undertake crossborder deals of targets with relatively higher innovation than will their counterparts from high innovation countries. I also expect that cross-border acquisitions by high-innovation firms in low innovation countries will generate greater acquirer shareholder value. Under the resourcebased view of the firm, obtaining innovation-related resources is essential for corporate growth and future increases in profitability (see e.g. Lee et al., 2001). In the domesticacquisition context, the empirical evidence shows that innovation-related acquisitions can generate greater increases in shareholder wealth (i.e. Danzon et al., 2007; Hassan et al., 2007; Desyllas and Hughes, 2010; Makri et al., 2010). Given that firms in low innovation markets likely face limited growth opportunities, the acquisition of innovation through cross-border deals should generate greater shareholder wealth than domestic deals. Hypothesis 5: High innovation acquirers in low innovation countries earn higher returns from undertaking a cross-border deal than they do from undertaking a domestic one. 2.3 DATA Sample Construction I collect data to enable me to examine the motives for an acquirer to acquire a target overseas. I examine several samples: an (acquirer) country-level sample, an acquirer-target country-pair sample (and a country-pair-year panel sample), and a cross-sectional sample of deal announcements. my sample is similar to Erel et al. (2012) except for two aspects. First, I also include countries from which the acquirers only do domestic deals 15

29 or only do cross-border deals (although the results are robust to removing such observations). This allows me to explain why some countries do not make or only make crossborder M&As. Second, I focus on the ratio of acquirer-country cross-border deals to domestic deals because I am mostly interested in examining how innovation in the acquirer s home country influences the decision to do a cross-border deal. This contrasts with Erel et al. (2012), who examine the ratio of cross-border deals in the target s country. The sample is based on M&A deal information from 1990 to 2010 from SDC platinum (as in Ferreira et al., 2010; Erel et al., 2012). I exclude LBOs, spin-offs, recapitalizations, self-tender offers, exchange offers, repurchases, partial equity-stake purchases, acquisitions of remaining interest, privatizations and deals in which the target and acquirer are the same, or there is a government agency, or a related party is from a financial or utilities industry. I exclude acquisitions involving the financial and utilities industries because they are more subject to government regulations, potentially biasing the results. I impose the sample restrictions that the relevant innovation data (from the World Bank) and the relevant control variables (from the year prior to the acquisition announcement) be available. After imposing all sample restrictions, the sample includes 85,549 M&A transactions from 57 countries. This is larger than the 12,750 observations in Ferreira et al. (2010); however, they require that both the bidder and target be publicly listed, and they look at M&As over a shorter time period ( ). The sample is smaller than the 187,841 observations used in Erel et al. (2012) because I require that firm-level accounting information (from WorldScope) is available. The country-level innovation variables are based on patent and non-patent measures of innovation, which I obtain from the World Bank, and are obtained at the aggregate country-level (they are not provided at the firm-level). Because I am interested in the role 16

30 of country-level innovation in motivating cross-border M&As, I examine patenting activity at the aggregate national level. To do this I obtain the number of patent applications by all residents in a country in year t 1, where the acquisition is announced in year t. Given that many of the regressions are at the aggregate national level, examining such aggregate figures is appropriate. I then construct several measures of patenting activity: the natural log of the number of patent applications, the number of patent applications scaled by GDP, and the number of patent applications scaled by the country s population. The first measure proxies the overall size of patenting activity, while the other two measures capture the capital and labour costs required to produce patents. However, I acknowledge that some countries might merely appear to be low innovation due to low patenting arising from a lack of intellectual property protection (per Da Rin et al., 2006). Subsequently, I also collect non-patent-based measures of innovation: the amount of total R&D expenditure to GDP, and the intensity of researchers in R&D in a country, as the availability of educated managers and employees is a necessary input for innovation (Ayyagari et al., 2012). These two measures capture a country s current innovation capacity and potential innovation output in the future. Since firms may be interested in acquiring both existing technology and innovation potential, I expect that these country characteristics will affect a firm s acquisition decision. Detailed definitions for the innovation variables are provided in the appendix. The corresponding summary statistics by country are reported in Table It is shown that I have 57 countries with available patent application data from the World Bank. The number of countries with available R&D/GDP and data on Researchers is 55 and 53, respectively. 4 The average annual number of resident patent application 3 This table is based on the observations for the country-level regressions, so the number of deals is larger than that reported for the deal-level regressions. 4 These become 54 and 52 in the country-level regressions due to the availability of data for the other control variables. 17

31 Table 2.1 Cross-border M&As, country-level innovation and firm-level innovation This table contains the number of M&As, the ratio of cross-border deals, the five innovation measures, and acquirer R&D ratio averaged over 1990 to 2010, for each of the 57 countries in the full sample (missing information is left as blank). Acquirer country All Deals Cross-border Ratio Patents Patents/GDP Patents/Pop R&D/GDP Researchers R&D/Assets Argentina % % % Australia % % % Austria % % % Belgium % % % Brazil % % % Bulgaria % % % Canada % % % Chile % % % China % % % Colombia % % % Czech % % % Denmark % % % Ecuador % % 71 Egypt % % % Finland % % % France % % % Germany % % % Greece % % % Hong Kong % % % Hungary % % % India % % % Indonesia % % % Ireland % % % Israel % % 6.11% Italy % % % Jamaica % % Japan % % % 18